FinCEN Final Rule vs 4th EU Money Laundering Directive

In May 2016, the Financial Crimes Enforcement Network (FinCEN) issued its long-awaited beneficial ownership rule with respect to customer due diligence requirements. Initially proposed in 2014, it was finally published as part of a wider range of reforms intended to counter money laundering, corruption, terrorism financing and tax evasion. By the time it is implemented in May 2018 (the rule provides a two-year implementation timeframe), it will have had a four-year incubation lifespan, which only reflects the significant compliance, operational and legal challenges that beneficial ownership identification and reporting poses for financial institutions.

At the same time, the forthcoming 4th EU Money Laundering directive places beneficial ownership in the centre of its focus for curbing money laundering and terrorism financing activities. It’s perhaps no coincidence that the onus on beneficial ownership has increased significantly since the Panama Papers and Bahamas leaks, spilling the financial details of ‘hundreds of thousands of accounts into the public realm.

Defining the fifth pillar: Beneficial ownership

The FinCEN Final Rule creates what is now termed the fifth pillar for anti-money laundering (AML) programmes, adding to the original four pillars of an AML programme under the USA Patriot Act which provides the foundation upon which AML enforcement practices are based. Essentially what this means is that financial institutions will be required to establish risk-based procedures for conducting ongoing customer due diligence (ODD), including the development of customer risk profiles, implementation of ongoing due diligence monitoring, updating of risk-based customer information and reporting of suspicious activities.

Under the Final Rule, legal entity customers can be split into two distinct types of beneficial owners:

Those with ownership i.e. an individual who – directly or indirectly – owns 25% or more of the equity interests of the legal entity customer.

Those with control i.e. a single individual with significant responsibility to control, manage or direct the legal entity customer (e.g. CEO, VP, Treasurer etc).

Important to note is that a beneficial owner cannot be another company or legal entity – it must be an individual – and each legal entity customer must have between one and five beneficial owners (up to four individuals with 25% equity interest plus the control beneficial owner or at the very least one control beneficial owner with 100% equity). However, the rule doesn’t apply to every legal entity equally, excluding certain legal entity customers from beneficial ownership identification and verification requirements.

Relatedly, the 4th EU Money Laundering Directive doesn’t veer too far from FinCEN’s definition and steers pretty close to the definition set out by its predecessor (the 3rd EU Directive), adding a revised clarification as to how such persons are to be identified. There are three parts to this:

According to the Directive, “a percentage of 25% plus one share… shall be evidence of ownership or control through shareholding and applies to every level of direct and indirect ownership.”

If there is any doubt that the person(s) identified above are the beneficial owner(s), the Directive states that “the natural person(s) who exercises control over the management of a legal entity through other means will be deemed the beneficial owner.”

If it is still not possible to identify the beneficial owner, the Directive states “the natural person(s) [i.e. not a legal entity] who hold the position of senior managing official(s)” will be deemed to be the ultimate beneficial owner (UBO).

10% beneficial owner threshold for heightened money laundering risk

However, where the 4th EU Money Laundering Directive and FinCEN diverge is that under new proposals, the European Commission seeks to lower to 10% the threshold set out in the Directive with respect to certain limited types of entities that present a specific risk of being used for money laundering and tax evasion. For intermediary entities that do not have any economic activity and only serve to distance the beneficial owners from the assets, the 25% threshold is fairly easy to circumvent. Establishing a lower threshold where there is a specific risk will limit the scope of entities on which the obliged entities would need to collect additional information to those where the risk of use for illicit purposes is high.

UBO beyond AML – The challenge of managing different levels of ownership

Of course, financial institutions need to manage UBO obligations across a number of regulatory frameworks (AML, KYC, CRS, and FATCA). Tax compliance regulations, in particular, such as FATCA, introduces a requirement for a 10% threshold for beneficial ownership (if the person displays US indicia), which is significantly higher than the 25% norm, which most AML/KYC regulations currently demand (for low-risk entities).

This is the part of beneficial ownership that will cause most operational headaches. Financial institutions will need to find a way to manage this on an ongoing level across various regulatory frameworks and jurisdictional regulations.